Question

Approximately Relevant ABC

Reducir, Inc., produces two different types of hydraulic cylinders. Reducir produces a major subassembly for the cylinders in the Cutting and Welding Department. Other parts and the subassembly are then assembled in the Assembly Department. The activities, expected costs, and drivers associated with these two manufacturing processes are given below.

Process	Activity	Cost	Activity Driver	Expected Quantity
Cutting and Welding	Welding	$ 776,000	Welding hours	4,000
	Machining	450,000	Machine hours	10,000
	Inspecting	448,250	No. of inspections	1,000
	Materials handling	300,000	No. of batches	12,000
	Setups	240,000	No. of setups	100
		$2,214,250
Assembly	Changeover	$ 180,000	Changeover hours	1,000
	Rework	61,750	Rework orders	50
	Testing	300,000	No. of tests	750
	Materials handling	380,000	No. of parts	50,000
	Engineering support	130,000	Engineering hours	2,000
		$1,051,750

Other overhead activities, their costs, and drivers are listed below.

Activity	Cost	Activity Driver	Quantity
Purchasing	$ 135,000	Purchase requisitions	500
Receiving	274,000	Receiving orders	2,000
Paying suppliers	225,000	No. of invoices	1,000
Providing space and utilities	100,000	Machine hours	10,000
Total	$ 734,000

Other production information concerning the two hydraulic cylinders is also provided:

	Cylinder A		Cylinder B
Units produced	1,500		3,000
Welding hours	1,600		2,400
Machine hours	3,000		7,000
Inspections	500		500
Moves	7,200		4,800
Batches	45		55
Changeover hours	540		460
Rework orders	5		45
No. of tests	500		250
Parts	40,000		10,000
Engineering hours	1,500		500
Requisitions	425		75
Receiving orders	1,800		200
Invoices	650		350

Process	Activity	Cost
Cutting and Welding	Welding	$ 2,000,000
	Machining	1,000,000
	Inspecting	50,000
	Materials handling	72,000
	Setups	400,000
		$3,522,000
Assembly	Changeover	$ 28,000
	Rework	50,000
	Testing	40,000
	Materials handling	60,000
	Engineering support	70,000
		$248,000

Other overhead activities:.

Activity	Cost
Purchasing	$ 50,000
Receiving	70,000
Paying suppliers	80,000
Providing space and utilities	30,000
	$230,000

The per unit overhead cost using the 14 activity-based drivers is $1,108 and $779 for Cylinder A and Cylinder B, respectively.

Required:

1. Determine the percentage of total costs represented by the three most expensive activities.

%

2. If required, round your interim calculations and final answers to the nearest dollar.
Allocate the costs of all other activities to the three activities identified in Requirement 1 in proportion to their individual activity costs.

	Allocation
Welding	$
Machining	$
Setups	$

Calculate the total activity costs of all the three activities.

	Cost pools
Welding	$
Machining	$
Setups	$

	Activity Rates
Welding	$	per welding hour
Machining	$	per machine hour
Setups	$	per batch

Now assign these total costs to the products using the drivers of the three chosen activities.

	Cylinder A		Cylinder B
Rate 1 (welding)	$		$
Rate 2 (machining)	$		$
Rate 3 (setups)	$		$
Total overhead costs	$		$
Unit overhead costs	$		$

3. Using the costs assigned in Requirement 2, calculate the percentage error using the ABC costs as a benchmark. Round your answers to one decimal place. If an item is negative, use a minus (-) sign to indicate.

	Percentage error
Cylinder A	%
Cylinder B	%

Answer 1

1. Activities highlighted in bold in last column are most expensive.

Activity	Cost	Expected Quantity	Cylinder A Units	Cylinder B Units	Cylinder A Cost	Cylinder B Cost	%age of total cost
Welding	2,000,000	4,000	1,600	2,400	800,000	1,200,000	50.00%
Machining	1,000,000	10,000	3,000	7,000	300,000	700,000	25.00%
Inspecting	50,000	1,000	500	500	25,000	25,000	1.25%
Materials handling	72,000	12,000	7,200	4,800	43,200	28,800	1.80%
Setups	400,000	100	45	55	180,000	220,000	10.00%
	3,522,000				1,348,200	2,173,800
Changeover	28,000	1,000	540	460	15,120	12,880	0.70%
Rework	50,000	50	5	45	5,000	45,000	1.25%
Testing	40,000	750	500	250	26,667	13,333	1.00%
Materials handling	60,000	50,000	40,000	10,000	48,000	12,000	1.50%
Engineering support	70,000	2,000	1,500	500	52,500	17,500	1.75%
	248,000				147,287	100,713
Purchasing	50,000	500	425	75	42,500	7,500	1.25%
Receiving	70,000	2,000	1,800	200	63,000	7,000	1.75%
Paying suppliers	80,000	1,000	650	350	52,000	28,000	2.00%
Providing space and utilities	30,000	10,000	3,000	7,000	9,000	21,000	0.75%
	230,000				166,500	63,500
	4,000,000				1,661,987	2,338,013	100.00%

2. Allocation of other activity costs:

Cost of other 11 activities	600,000
	Actual Cost	Allocation Cost
Welding	2,000,000	352,941
Machining	1,000,000	176,471
Setups	400,000	70,588
Total	3,400,000	600,000

Total Activity Costs:

	Actual Cost	Allocation Cost	Total Costs
Welding	2,000,000	352,941	2,352,941
Machining	1,000,000	176,471	1,176,471
Setups	400,000	70,588	470,588
Total	3,400,000	600,000	4,000,000

Activity rates:

	Total Costs	Expected Quantity	Activity Rates
Welding	2,352,941	4,000	588
Machining	1,176,471	10,000	118
Setups	470,588	100	4,706
Total	4,000,000

Total Costs to products:

	Total Costs	Expected Quantity	Activity Rates	Cylinder A Units	Cylinder B Units	Cylinder A Cost	Cylinder B Cost
Welding	2,352,941	4,000	588	1,600	2,400	941,176	1,411,765
Machining	1,176,471	10,000	118	3,000	7,000	352,941	823,530
Setups	470,588	100	4,706	45	55	211,765	258,823
Total	4,000,000				Total Overhead costs	1,505,882	2,494,118
					Units	1,500	3,000
					Unit overhead costs	1,004	831

3. Percentage error using ABC costs as benchmark:

To calculate %age error, we need to allocate expected costs of ABC into Cylinder A and B as we did in req 2:

Activity	Cost	Expected Quantity	Cylinder A Units	Cylinder B Units	Cylinder A Cost	Cylinder B Cost
Welding	776,000	4,000	1,600	2,400	310,400	465,600
Machining	450,000	10,000	3,000	7,000	135,000	315,000
Inspecting	448,250	1,000	500	500	224,125	224,125
Materials handling	300,000	12,000	7,200	4,800	180,000	120,000
Setups	240,000	100	45	55	108,000	132,000
	2,214,250				957,525	1,256,725
Changeover	180,000	1,000	540	460	97,200	82,800
Rework	61,750	50	5	45	6,175	55,575
Testing	300,000	750	500	250	200,000	100,000
Materials handling	380,000	50,000	40,000	10,000	304,000	76,000
Engineering support	130,000	2,000	1,500	500	97,500	32,500
	1,051,750				704,875	346,875
Purchasing	135,000	500	425	75	114,750	20,250
Receiving	274,000	2,000	1,800	200	246,600	27,400
Paying suppliers	225,000	1,000	650	350	146,250	78,750
Providing space and utilities	100,000	10,000	3,000	7,000	30,000	70,000
	734,000				537,600	196,400
	4,000,000			Expected Costs	2,200,000	1,800,000

Percent error:

	Cylinder A	Cylinder B
Expected Costs	2,200,000	1,800,000
Actual Costs	1661987	2338013
Percent Error	-24.46%	29.89%